By Beau Ruff
Should a person gift
the farm before death to avoid the complexity of probate and the estate tax?
The family farm
occupies a unique position in Washington state estate taxation. It is arguably
one of the best assets to own at death for a wealthy family. It has the benefit
of both protections from the estate tax while still garnering an income tax
boon with a tax basis step-up at death allowing the virtual income-tax-free
sale of property after death. This column digs into the concept a little
First, a reminder on
the applicable estate taxes. For 2019, the federal government imposes an estate
tax on estates valued at more than $11.4 million, and Washington state imposes
the estate tax on estates valued at over $2.2 million. As is clearly evident,
the Washington estate tax hits many more people in Washington than the federal
One option to avoid
probate and the application of Washington’s estate tax is to gift property
before death. This is a common technique in estate planning, especially as it
relates to estate tax reduction. But, gifting would not likely maximize tax
benefits for the Washington farmer from an income tax point of view.
death, there is a little-known tax benefit that the federal government
provides. It is an adjustment to tax basis and it can have a profound effect on
the taxation of the assets owned at death. The tax code provides a boon for
individuals with capital assets (think stocks, land, buildings, real estate,
farms, etc.). That is, at death, the asset gets a new basis equal to its then
current fair market value. Take the example of a farm—if it is sold after
death, it gets a new tax basis equal to the then current fair market value.
Accordingly, when it is sold for that current fair market value, there is no
income-tax owing. This means that when sold at the then-current fair market
value, there will be zero income tax assessed on the sale of the capital asset
after death. Conversely, if the property is gifted prior to death, it receives
no such tax basis step-up and a sale could incur a substantial income tax bill.
But, by keeping the
property until death and not gifting, the farmer might expose the estate to the
Washington estate tax. Luckily for the farmer, Washington state provides relief
for the farmer from the Washington estate tax while still allowing the farm to
qualify for the federal step-up in tax basis.
farmer is “land rich but cash poor.” The theory then is that it is burdensome
for family farms to pay the Washington state estate tax. At the same time
perhaps the Legislature wanted to provide an incentive for the retention of
The relevant rules
are contained in RCW 83.100.046 as well as in the associated WAC 458-57-155.
Those two bodies of law lay out the precise rules that allow the farm deduction
and the stringent requirements that must be met. But, if the farm meets the
qualifications, then for purposes of determining the Washington taxable estate
(i.e. whether and to what extent the estate is subject to the Washington estate
tax), a deduction is allowed for the total value of the farm.
For example, assume
that Farmer A has an estate valued at $11 million, of which $10 million is the
value of the farm that meets all the requirements contained in both WAC
458-57-155 and RCW 83.100.46. Assume further that Farmer A passes away. Then
that estate would pay zero estate tax under federal law (as it is under the
current credit amount) and zero estate tax under the state of Washington estate
tax (even though it is about $9 million over the applicable exemption amount).
At the same time, the farmer’s farm is still entitled to the step up in tax basis. Accordingly, the farmer’s estate avoids the imposition of the estate tax while at the same time benefiting for a later reduction in income tax for his heirs. The family farm can produce benefits beyond its crops with thoughtful planning and utilization of current tax laws. It is important to note that not every farm and not every farmer will qualify for this generous deduction. As always, it is important to work with a qualified attorney and CPA to properly plan the best course of action for any individual estate plan.
Attorney Beau Ruff works for Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick.
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